Hedge Fund Outlook Continues To Improve

After weathering a dismal 2008, a disastrous 2009 and a decent 2010, things are definitely looking up for hedge funds this year thanks to improving economic conditions around the world and an influx of new capital from institutional investors, pension funds and sovereign wealth funds.

Hedge fund assets are now perched at an all-time high -- more than $2 trillion assets under management at the end of 2010 -- despite looming regulatory changes and increased scrutiny in the wake of the Dodd-Frank Wall Street Reform Act.

As the industry embarks on a renaissance of sorts, fund managers expect to increase their headcounts, know they'll face more competition from upstarts and will rely more on seed capital to feather new ventures, according a new report from auditing and accounting firm Rothstein Kass.

The report, based on an online survey of 313 hedge fund managers, found that only one in three believe 2011 will a "difficult" year for the hedge fund industry compared to 70% who felt a tremendous sense of dread heading into 2010.

Almost 75% of respondents said they expect more hedge funds will be launched in 2011 and 60% predict there will be fewer hedge fund closures this year than last. A strong majority (62%) indicated that they new funds and the expansion of other hedge funds will be larger dependent on seed capital from outside investors.

A nice benefit of both the improving economic climate and the expected increase in new hedge funds -- as well as the survival of existing ones -- is that managers will have a much broader and deeper pool of talent to choose from to fill their ranks. Sixty-two percent of respondents said they'll benefit from this inflow of talent from other segments of the financial services industry.

"Over the past two years, the sector has again shown its resilience by adapting to meet the evolving needs of its investors," Howard Altman, Co-CEO of Rothstein Kass, said in the report. "More than 70% of hedge fund managers anticipate that institutional investors will be the dominant source of new capital in 2011."

This marks a dramatic about-face, Altman said, from just five years ago when only 20% of hedge fund managers were expecting institutional money to represent the lion's share of hedge fund assets.

"Those firms that took the lead in developing and implementing institutional-quality operational practices -- from succession planning to reporting -- are now benefiting from increasing allocations from pension and defined benefits plans seeking to overcome their own funding shortfalls deepened by the crisis," Altman added.

Digging deeper into the survey, 85% of hedge fund managers said they expect institutional investors to be more averse to high concentrations of illiquid portfolio assets in 2011 than they have in recent years. Eighty-percent acknowledged that most institutional investors will continue to prefer larger hedge funds and 65% said they'll have to more frequently offer special terms to pension funds and sovereign wealth funds to assure their business.

Just over 75% of fund managers said they expect to increase their assets under management in 2011 and 60% are predicting an increase of at least 25%.